[Federal Register Volume 63, Number 5 (Thursday, January 8, 1998)]
[Notices]
[Pages 1131-1134]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-418]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39510; File No. SR-NASD-97-24]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval to
Amendment No. 1 to the Proposed Rule Change by the National Association
of Securities Dealers, Inc. Relating to Supervision and Record
Retention Rules
December 31, 1997.
I. Introduction
On April 11, 1997, the NASD Regulation, Inc. (``NASDR'') submitted
to the Securities and Exchange Commission (``SEC'' or ``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to
amend the supervision and record retention rules of the National
Association of Securities Dealers, Inc.'s (``NASD'' or ``Association'')
to provide firms with flexibility in developing reasonable procedures
for the review of correspondence with the public. The proposed rule
change was published for comment in the Federal Register on May 2,
1997.\3\ One comment was received on the proposal.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 38548 (April 25,
1997), 62 FR 24147.
\4\ See Letter from William P. Hayes, Chairman, PSA The Bond
Market Trade Association (``PSA'') Fixed Income Practices and
Procedures Working Group, to Jonathan G. Katz, Secretary,
Commission, dated June 3, 1997 (``PSA Letter'').
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On December 4, 1997, NASDR submitted Amendment No. 1 to the
proposed rule change.\5\ This order approves the proposal, and approves
Amendment No. 1 to the proposed rule change on an accelerated basis.
The Commission also is approving a substantially identical proposal by
the New York Stock Exchange, Inc. (``NYSE'').\6\
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\5\ See Letter from Mary N. Revell, Associate General Counsel,
NASDR, to Katherine A. England, Assistant Director, Division of
Market Regulation, Commission, dated December 1, 1997 (``Amendment
No. 1''). Amendment No. 1 contains a Notice to Members (``Notice to
Members''), to be issued following Commission approval of the
proposed rule change, which describes the new rules for supervision
of public correspondence and provides guidance to NASD members on
the implementation of the new rules.
\6\ See Securities Exchange Act Release No. 39511 (December 31,
1997) (order approving File No. SR-NYSE-96-26).
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II. Background and Description of the Proposal
In May 1996, the Commission issued an Interpretive Release on the
Use of Electronic Media by Broker-Dealers, Transfer Agents, and
Investment Advisers for Delivery of Information.\7\ The release
expressed the views of the Commission with respect to the delivery of
information through electronic media pursuant to the federal securities
laws, but did not address the applicability of any self-regulatory
organization (``SRO'') rules. In the release the Commission did,
however, strongly encourage the SROs to work with broker-dealer firms
to adapt SRO supervisory review requirements governing communications
with customers to accommodate the use of electronic communications.\8\
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\7\ See Release Nos. 33-7288, 34-37182, IC-21945, IA-1562 (May
9, 1996) 61 FR 24644 (May 15, 1996) (File No. S7-13-96).
\8\ Id.
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On September 12, 1996, the NYSE filed with the Commission a
proposal to update its rules governing supervision of its member firms'
communications
[[Page 1132]]
with the public.\9\ Similarly, NASDR proposes to amend NASD Rules 3010,
``Supervision,'' and 3110, ``Books and Records,'' to provide firms with
flexibility in developing reasonable procedures for the review of
correspondence with the public. The NASDR's proposal, like the NYSE's
proposal, reflects the growing use of new technology and means of
cummunicaiton (e.g., ``e-mail'' and the Internet) which have affected
the way broker-dealers and their associated persons conduct business
and communicate with customers and other members of the public.
According to NASDR, to ensure a coordinated regulatory framework for
the supervision of written and electronic correspondence, its proposal
is designed to be consistent with the NYSE's proposal.
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\9\ See Securities Exchange Act Release No. 37941 (November 13,
1996) 61 FR 58919 (November 19, 1996) (File No. SR-NYSE-96-26)
(soliciting comment on the NYSE's proposed rule change).
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Currently, NASD Rule 3010(d) requires each member firm to establish
procedures for the review and endorsement by a registered principal of
all transactions and all correspondence of its registered
representatives pertaining to the solicitation or execution of any
securities transactions. Under the proposal, a review of each item of
correspondence no longer will be required. Instead, proposed NASD Rule
3010(d)(1) provides that a firm must establish procedures for the
review by a registered principal of each registered representative's
outgoing and incoming written and electronic correspondence with the
public relating to the member's investment banking or securities
business. Under the proposal, member firms must: (1) Develop written
supervisory policies and procedures; (2) design policies and procedures
to provide reasonable supervision of each registered representative;
and (3) maintain evidence that supervisory policies and procedures have
been implemented and executed and make that evidence available to the
Association upon request.
A broker-dealer's policies and procedures for reviewing the public
correspondence of registered representatives also must satisfy the
requirements of new NASD Rule 3010(d)(2). As proposed, NASD Rule
3010(d)(2) requires each member to develop written procedures for
review of incoming and outgoing written and electronic correspondence
that are appropriate to the broker-dealer's business, size, structure
and customers. Pursuant to the proposal, a broker-dealer that does not
require pre-use review of all correspondence must: (1) Educate and
train associated persons as to the firm's procedures governing
correspondence; (2) document such education and training; and (3)
monitor and test to ensure implementation of and compliance with the
firm's policies and procedures.
The NASD has developed a Notice to Members that provides additional
guidance and requirements for supervisory procedures adopted pursuant
to NASD Rule 3010. In developing written supervisory procedures,
members should, among other thing,: (1) Specify the firm's policies and
procedures for reviewing different types of communications; (2)
identify how supervisory reviews will be conducted and documented; (3)
identify what types of communications will be pre-reviewed or post-
reviewed; (4) identify the organizational positions responsible for
conducting reviews of the different types of communications; (5)
specify the minimum frequency of reviews for each type of
communication; (6) monitor the implementation of and compliance with
the firm's procedures for reviewing public correspondence; and (7)
periodically re-evaluate the effectiveness of the firm's procedures for
reviewing public communications and consider any necessary revisions.
In addition, the Notice to Members requires broker-dealer to: (1)
Specify procedures for reviewing registered representatives'
recommendations to customers; (2) require supervisory review of some of
each registered representative's public communications, including his
or her recommendations to customers; and (3) consider the complaint and
overall disciplinary history, if any, of registered representatives and
other employees. The Notice to Members also states that a broker-
dealer's supervisory policies and procedures must ensure that all
customer complaints, whether received via e-mail or in written form
from the customer, are reported to the NASD in compliance with NASD
Rule 3070(c)\10\ and that a broker-dealer must prohibit employees' use
of electronic correspondence to the public unless the communications
are subject to the supervisory and review procedures developed by the
firm.
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\10\ Among other things, NASD Rule 3070(c) requires members to
report to the NASD statistical information regarding customer
complaints relating to matters specified by the NASD.
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Moreover, under new NASD 3010(d)(3), each member must retain
correspondence in accordance with amended NASD Rule 3110. NASD Rule
3010(d) (3) further requires that the names of the persons who prepared
and reviewed outgoing correspondence must be ascertainable from the
retained records and the records must be made available to the NASD
upon request.
Finally, the NASD proposes to amend NASD Rule 3110 to require that
records must be made and preserved as prescribed by all applicable
laws, rules, regulations, NASD rules and with Rule 17a-3 under the Act.
The record keeping format, medium, and retention period must comply
with Rule 17a-4 under the Act.
III. Summary of Comments
The Commission received one comment letter on the proposed rule
change.\11\ The commenter generally supported the proposal.
Specifically, the PSA believes the proposal will provide flexibility
for member firms to develop procedures for review of correspondence.
The PSA believes that procedures tailored by individual firms to meet
their needs are preferable to a uniform set of detailed requirements
that may be inappropriate for many firms or that may quickly become
obsolete. The PSA expressed its support for the Association's efforts
to ensure a coordinated regulatory framework for the supervision of
manual and electronic communications by harmonizing its new
requirements with those of the Commission and the NYSE.\12\
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\11\ See PSA Letter, supra note 4.
\12\ Id.
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IV. Discussion
After careful review, the Commission finds that the proposed rule
change is consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities
association.\13\ Specifically, the Commission believes the proposal is
consistent with the requirements of Section 15A(b)(6) of the Act\14\ in
that is designed to prevent fraudulent and manipulative acts and
practices and to protect investors and the public interest. As noted
above, NASD Rule 3010(d)(1), as amended, will allow broker-dealers to
establish reasonable procedures for review of registered
representatives' correspondence with the public relating to their
business. New NASD Rule 3010(d)(2) will require broker-dealers to
develop written policies and procedures for the review of all
associated persons'
[[Page 1133]]
public communications that are appropriate for the broker-dealer's
business, size, structure, and customers. The Commission believes that
the proposed rules will provide broker-dealers with some flexibility in
adopting and implementing supervisory procedures for reviewing
associated persons' public communications while establishing minimum
requirements, guidelines, and standards governing the supervisory
procedures a broker-dealer may adopt. The Commission believes that
these standards and guidelines will help to ensure that broker-dealers
continue to provide appropriate supervision of the public
communications of their associated persons.
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\13\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
\14\ 15 U.S.C. 78o-3(b)(6).
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The Commission believes that the proposal does not diminish the
general supervisory responsibilities of broker-dealers. In this regard,
the Commission emphasizes, as it has stated previously, that broker-
dealers must monitor the trading and sales activities of their
associated persons and establish effective compliance and supervisory
procedures to prevent and detect possible violations of firm policies
and procedures, rules of the SROs, and federal and state securities
laws.\15\ The Commission believes that review of registered
representatives' and other associated persons' public correspondence is
an important component of a broker-dealer duty to supervise its
employees, and that broker-dealers have substantial supervisory
obligations arising from the public communications of their associated
persons.
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\15\ See NASD, NYSE, North American Securities Administrators
Association, Inc. and Office of Compliance, Inspections and
Examinations, Commission, Joint Regulatory Sales Practice Sweep
(1996) (``Joint Sweep Report'') at 1.
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The Commission believes that the minimum standards and requirements
specified in NASD Rule 3010 and in the Notice to Members will help to
ensure that broker-dealers continue to provide appropriate supervision
of the public communications of their registered representatives and
other associated persons. In this regard, the Commission notes that
NASD Rule 3010(d)(1) states that a broker-dealer's supervisory policies
and procedures must be designed to reasonably supervise each registered
representative. Under NASD Rule 3010(d)(2), a broker-dealer that
chooses not to require pre-use review of public communications must
educate employees about the firm's current communications policies and
procedures, document the employees' education and training, and ensure
that the firm's policies are implemented and adhered to.
In addition, the Notice to Members require broker-dealers to: (1)
Specify, in writing, the firm's policies and procedures for reviewing
different types of communications; (2) identify how supervisory reviews
will be conducted and documented; (3) identify what types of
communications will be pre-reviewed or post-reviewed; (4) identify the
positions within the organization responsible for conducting reviews of
the different types of communications; (5) specify the minimum
frequency of reviews for different types of communications; (6) monitor
the implementation of and compliance with the firm's procedures for
reviewing public communications; and (7) periodically re-evaluate the
effectiveness of the firm's procedures for reviewing public
communications and consider any necessary revisions.
The Commission believes that these requirements will provide
guidance to broker-dealers in developing policies for supervising
public communications and to associated persons in complying with the
firm's policies. The requirements should help to ensure that broker-
dealers carefully consider the supervisory procedures appropriate for
different types of communications, closely monitor compliance with
their firm's policies, and periodically reevaluate their firm's
policies and procedures. The Commission expects broker-dealers to
monitor the effectiveness of their supervisory policies and procedures
and to promptly make any necessary revisions.
The Notice to Members also requires broker-dealers to: (1) Specify
procedures for reviewing registered representatives' recommendations to
customers; (2) require supervisory review of some of each registered
representative's public communications, including his or her
recommendations to customers; (3) consider the complaint and overall
disciplinary history, if any of registered representatives and other
employees in developing procedures for supervising their communications
with the public; (4) provide that all customer complaints, whether
received via e-mail or in written form from the customer, are reported
to the NASD in compliance with NASD Rule 3070(c); and (5) prohibit
employees' use of electronic communications to the public unless the
communications are subject to supervisory and review procedures
developed by the firm.
The Commission believes that these standards will help to ensure
that broker-dealers adopt effective and appropriate supervisory
procedures. For example, reviewing at least some of each registered
representative's recommendations \16\ and providing for the reporting
of customer complaints in compliance with NASD Rule 3070(c) may help
firms to identify potential sales practice problems. Similarly,
considering a registered representative's complaint and overall
disciplinary history will help to ensure that broker-dealers implement
supervisory procedures appropriate for each representative. In this
regard, the Commission would expect a broker-dealer to consider
providing heightened supervision for a registered representative with a
history or pattern of customer complaints, disciplinary actions or
arbitrations.\17\ Moreover, the Commission notes that the requirements
specified in NASD Rule 3010 and in the Notice to Members are minimum
requirements; the Commission expects each broker-dealer to implement
any additional procedures the broker-dealer believes are necessary to
provide appropriate supervision of all of its associated persons.
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\16\ With regard to recommendations, the Commission notes that
NASD Rule 2310 requires, among other things, that a recommendation
have a basis which can be substantiated as reasonable. Regardless of
the supervisory procedures a broker-dealer adopts, the broker-dealer
must continue to ensure compliance with NASD Rule 2310 and any other
relevant rule.
\17\ Similarly, the Joint Sweep Report stated that ``[f]irms
that hire registered persons that have a history or pattern of
customer complaints, disciplinary actions, or arbitrations are
responsible for imposing close supervision over those persons.
`Normal' supervision is simply not enough; firms must craft special
supervisory procedures tailored to the individual representative.''
See Joint Sweep Report, supra note 21, at vi. See also NASD Notice
to Members 97-19 (firm that hires a registered representative with a
recent history of customer complaints, final disciplinary actions
involving sales practice abuse or other customer harm, or adverse
arbitration decision should determine if it is necessary to develop
and implement special supervisory procedures tailored to the
individual registered representative).
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The Commission believes that several requirements specific to
electronic communications will further help to ensure that firms adopt
appropriate supervisory procedures. In this regard, the Commission
notes that the Notice to Members provides that a firm's policies and
procedures must prohibit registered representatives' and other
employees' use of electronic communications to the public unless those
communications are subject to supervisory and review procedures
developed by the firm. The NASD Notice to Members also states that the
Association expects members to prohibit communications with the public
from employees' home computers or through third party computer systems
unless the firm is
[[Page 1134]]
capable of monitoring the communications.
The Commission believes that the provision for review of incoming
non-electronic correspondence also is designed to protect investors.
The Commission notes that the Notice to Members mandates that Rule
3010(d) will continue to require review of all incoming non-electronic
correspondence directed to registered representatives.\18\ The
Commission believes that this requirement may provide a broker-dealer
with early notice of sales practice problems and help to ensure proper
handling of customer funds. Incoming non-electronic correspondence
directed to associated persons other than registered representatives,
and all incoming communications in electronic format, will be subject
to the policies and procedures the firm establishes pursuant to NASD
Rule 3010(d).
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\18\ See Notice to Members, supra note 5. The requirement to
review all incoming non-electronic correspondence directed to
registered representatives is not specified in the text of the rule
language. This requirement parallels a NYSE provision contained in
Interpretation 342.16/04 in the NYSE Interpretation Handbook. The
NASD's requirement is set forth only in its Notice to Members which
was submitted by NASDR as an amendment to the original rule filing;
therefore, NASD member firms must comply with this additional
requirement, as well as with the other specific requirements set
forth in the Notice to Members.
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The NASD represents that it will review members' procedures and
systems periodically to ensure that they are reasonable in view of the
firm's structure, the nature and size of its business, and its customer
base.\19\ The Commission expects the NASD to monitor closely the
policies and procedures firms adopt pursuant to the proposal to ensure
that they satisfy the requirements of NASD Rule 3010. In addition, the
Commission expects the NASD to review NASD Rule 3010 as it gains
experience with the rules and to consider any necessary revisions,
including additional minimum requirements for broker-dealers'
communication policies.
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\19\ Id.
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Finally, the Commission believes that it is reasonable for the NASD
to amend NASD Rule 3110 to indicate that members must preserve books
and records as required under SEC Rule 17a-3 and comply with the
recordkeeping format, medium and retention period specified in SEC Rule
17a-4 in order to clarify the recordkeeping requirements applicable to
broker-dealers.
The Commission finds good cause for approving proposed Amendment
No. 1 prior to the thirtieth day after the date of publication of
notice of filing thereof in the Federal Register. The Commission notes
that Amendment No. 1, which incorporates the Notice to Members into the
proposal, further clarifies the Association's new rules by providing
additional guidance to NASD members. As discussed more fully above, the
Notice to Members provides additional requirements and guidelines for
broker-dealers' supervisory policies. Accordingly, the Commission
believes that it is consistent with Section 15(b)(6) of the Act \20\ to
approve Amendment No. 1 to the proposed rule change on an accelerated
basis.
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\20\ 15 U.S.C. 78o-3(b)(6).
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V. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 1. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549. Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying in the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of all such filings will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to File No. SR-NASD-97-24 and should
be submitted by January 29, 1998.
VI. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\21\ That the proposed rule change (SR-NASD-97-24), including
Amendment No. 1, is approved.
\21\15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulations,
pursuant to delegated authority.\22\
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\22\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 98-418 Filed 1-7-98; 8:45 am]
BILLING CODE 8010-01-M